The commodity crisis

HICHAEL SALTER April 14 1986

The commodity crisis

HICHAEL SALTER April 14 1986

The commodity crisis


It was clearly a sign of the times. Last week, as oil prices hovered around $10 (U.S.) a barrel, analysts predicted that prices could fall as low as $5 a barrel by this summer. But the collapse in oil prices was only the most visible indication of another new and far-reaching trend. Since 1980 most of the world’s basic raw materials producers, from wheat and lumber to steel and tin, have been experiencing low prices caused by a huge oversupply of goods. And the low commodity prices affect not only primary producers—grain farmers and coal miners—but those who turn raw materials into manufactured and processed goods—aluminum cans, steel pipe, newsprint or two-by-fours. Said William Mackness, chief economist and senior vice-president at the Bank of Nova Scotia: “The commodity price collapse is one of the biggest changes in the postwar period to Canada’s economy. It is a watershed event.”

Of all the industrialized countries, Canada may suffer most from the

commodity price decline. The country’s primary sector is proportionally about twice as large as in the other major industrialized nations. And tough global competition has forced Canadian companies to become far more technologically innovative and efficient merely to survive. But the equipment needed to increase productivity is permanently eliminating jobs in dozens of industries. That is damaging the economic health of towns, cities and regions where those companies are concentrated—largely outside of central Canada. And the current oil price decline, coupled with falling grain prices, is expected to increase unemployment and slow growth, especially on the prairies. Said Alex Kelly, an economics professor at the University of Regina: “We are in for a long-term decline in our standard of living.”

Across Canada, prices for many commodities, usually traded in U.S dollars, have dropped spectacularly in the past five years. In Saskatchewan, world uranium prices peaked at $43.25

a pound in 1978, then began a steady decline to a low of $15.25 a pound in

1984. The price is now up marginally at $17 a pound. In Montreal, executives at Alcan Aluminium Ltd. say that they are encouraged because prices have rebounded this year to about 53 cents a pound from last year’s average of 47 cents—still far from their historic high of 97 cents in 1980. But Alcan chief economist Gilles Proulx says, “Good prices could prompt idle smelters to start up again, creating a glut that will knock prices back down.”

Many other experts also say that while many commodities—excluding oil —likely hit their lowest levels in

1985, price increases for the remainder of the decade will be extremely gradual because of chronic oversupply. Lumber, for one, recently edged past a healthy $200 per 1,000-boardfeet, up from a recession low of $141 in 1982. But executives at forestry giant MacMillan Bloedel Ltd. in Vancouver say that the price will fall later this year.

Steel producers, too, face excess worldwide capacity of 100 million tons annually. Because of that, the price of steel plate—at $385 per ton—sold by Hamilton, Ont.-based Stelco Inc., has not increased in three years, said Kent Newcomb, manager of economics, and it is still below the 1982 price of $400 a ton.

Farmers on the Canadian prairies will also experience another drop in income this year as wheat prices fall because of the impact of the U.S. Farm Bill, which takes effect for the 1986 crop year. The legislation reduces the price that Washington guarantees farmers for their wheat —support that has effectively created an artificially high floor price. And because wheat—like other commodities—is in huge oversupply, prices in the United States have already declined to about $2.50 a bushel from last year’s average of $3.30.

Predicted University of Regina’s Kelly: “We are going to see a migration out of agriculture.”

Commodities have traditionally gone through boom and bust cycles. As demand grows and supplies tighten, prices and profits shoot up, enticing companies to expand their production capacity. When supply begins to outstrip demand, prices start to fall. During the 1960s, commodity-producing nations, particularly in the Third World, formed cartels in an attempt to protect themselves from price fluctuations. They also wanted to force prices up because, in the postwar period, the rise in the cost of manufactured goods generally outstripped any increase in commodity prices. Partly because of that, cartels for tin, uranium and oil—such as the Organization of Petroleum Exporting Countries (OPEC)—were formed.

But in the early 1970s the postwar pattern was abrubtly shattered when commodity prices soared to record heights. Led by huge OPEC-engineered, oil-price increases, and fuelled by strong demand initially caused by the Vietnam War, commodity prices exploded upward in two great upheavals—1972 to 1974 and 1978 to 1980.

Good prices and large profits led to an almost unparalleled increase in supply as producing nations rushed to plant more crops and open new mines and mills. “It was the largest increase in world supply ever seen,” Mackness said. Another reason the supply was so extreme was that throughout the

1970s, price inflation consistently outpaced the cost of loans, prompting companies to borrow for expansion.

As well, money for expansion started flooding into the developing nations. Partly because oil profits had to be reinvested and partly because of the growing expansion of the world’s banking system, the Third World found it relatively easy to borrow. The result: new sources of competition from low-wage nations not only in commodities but in processed goods.

Because it takes so long to open

mines and factories, many of them did not start producing until the late 1970s. But by 1980 there was a massive oversupply of many commodities— from wheat and tin to aluminum and steel. Prices began to slide and commodity cartels lost their power. OPEC’s loss of influence is only the most glaring case of failure.

Last October, the 29-year-old Inter-

national Tin Council, which was the world’s oldest cartel, stopped trading on the London Metal Exchange when it could not resolve a financial crisis caused by oversupply problems. Tin is now trading at $5,440 a ton, down from $11,970 before the ITC collapsed.

Many economists and executives say that because the oversupply problem is so severe, the current price collapse will not be followed, as it has been traditionally, by a new boom—at least not for the rest of the 1980s. Declared Mackness: “The excess supply is international—and it is chronic.” Added John Dickinson, vice-president of planning for MacMillan Bloedel: “Our new motto is that ‘the market will no longer bail us out.’ ”

Indeed, major Canadian companies are investing millions to make more specialized, profitable products. MacMillan Bloedel, for one, is now making higher grades of newsprint for advertising supplements, as well as cutting lumber to unusual 5 specifications to satisfy I Japanese builders.

Q For its part, Alcan— after losing $180 million last year— has embarked on a major campaign to return to profitability. The company has reduced its workforce to 67,000 from 70,000 in 1984. And, in order to concentrate on its core aluminum business, it is in the midst of selling off much of its foreign holdings. Said Proulx: “We need more emphasis on adding value to our products.” To that end, Alcan has increased its spending on research and development to $77 million last year from $66 million in 1983. And the company has a set a goal of having 25 per cent of its sales in the 1990s coming from aluminum-based products that it is not yet making.

This year’s shattering drop in the price of oil may help the recovery of other commodity prices. Because lower oil prices put more money into the hands of consumers, countries and industries that use the fuel heavily, demand for some other goods and commodities should rise—within a year or two, said Edward Carmichael, senior policy analyst at the C.D. Howe Institute in Toronto. Hundreds of thousands of Canadians employed in the commodity sector are counting on it.